Cisco: Results Impress, Guidance Encouraging, Challenges Remain

Cisco announced encouraging second-quarter financial results at the close of trading yesterday. It also provided robust guidance for the quarter ahead, even if its optimism was of an understandably cautious vintage.

In the technology space, Cisco CEO John Chambers and his team rank near the top in the way they deal with the analyst and investor community. Cisco set up this “market beat” perfectly, and it struck the right tone regarding outlook. Really, Chambers and company are masterful in how they prepare for and execute these quarterly calls with analysts and investors. These calls are like performances, in that a lot of preproduction work goes on behind the scenes before the event itself.

Not that there’s any sleight of hand in Cisco’s actual results, though. The numbers were solid. As Cisco said, quarterly results were relatively strong across product lines, industry sectors, and geographies. Some were better than others, though, and I’ll touch on that later.

Cisco is happy enough with its results and, more important, with its business prospects that it will begin hiring in anticipation of continued growth in established market segments as well as in sectors that are relatively new to the company. All told, Cisco will add from 2,000 to 3,000 positions, though we don’t know where in the world those jobs will materialize or how they’ll be apportioned departmentally. We can keep an eye of the Cisco employment board to find out.

The networking giant signaled that it will be aggressive in partnerships and acquisitions, too.

After trending downward for a few quarters, Cisco’s operating cash flow spiked on both a sequential and year-over-year basis, with the company now holding cash and cash equivalents of more than $39.6 billion. A caveat is that most of that money — about $35 billion, by my back-of-envelope estimation — is held overseas. Cisco is unwilling to repatriate that money, and to incur attendant taxation, so it probably will seek purchases in foreign markets wherever possible.

Cisco obviously hopes that its stock will become more attractive as acquisition-related currency. Cisco is talking up the recovery, which the company says has entered a “second stage” (though those of us who weren’t playing the public markets might have missed the initial stage entirely). It also has continued its share-repurchase program. Obviously, to accept Cisco stock in lieu of hard cash, target companies and their backers would have to be confident that Cisco’s shares will appreciate rather than languish.

We know Cisco beat the Street’s expectations like a rented mule. It beat even the high-end revenue and earnings estimates of analysts. What’s more, it issued bullish guidance that was ahead of consensus projections from the analyst community. It’s all good, right?

Well, it’s good for now. That said, the price of business success is eternal vigilance, and Cisco must remain alert to both threats and opportunities. It must also be able to distinguish between the two.

Blemishes included a modest dip in gross margins and faltering performance in Europe and emerging markets (not including India and China, the latter where Cisco is reorganizing to position itself for better results against China’s homegrown Huawei and 3Com, which has a huge Chinese workforce as a result of its earlier partnership with Huawei).

Also of concern is Cisco’s nominal growth in its “advanced technologies” segment, which includes many of its emerging businesses in so-called market adjacencies. Revenue in advanced technologies grew just one percent in the quarter on a year-over-year basis.

Cisco will place considerable emphasis on improved performance in these segments, which represent the company’s future growth. Cisco saw some long-deferred equipment upgrades and refreshes from its North American enterprise customers in the just-concluded quarter, but it will need to sell them new products as well as replacement gear to drive meaningful, sustained growth.

Fully aware of this conundrum, Cisco must be concerned to see its video business down 12 percent. This puts the Tandberg acquisition into an interesting new light, explaining why Cisco heralded it when first announcing it back in October and why Cisco was disinclined to walk away when a significant percentage of Tandberg shareholders banged their fists on the table and demanded a sweetened offer.

Other areas of Cisco advanced technologies that were down include application networking, the networked home, and storage. Security was flat.

On the positive side, unified communications was up a whopping 17 percent, and wireless grew in high single digits. Chambers also reported that enterprises have responded favorably to the company’s Unified Computing System (UCS), with more than 400 customers placing orders.

I’m sure we’ll see Cisco working hard organically and through acquisition to get all its advanced technologies performing as well as its unified communications and wireless groups. It also will continue looking for more market adjacencies.

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